DETERMINING TAXES ON A RESIDENTIAL SALE IN ILLINOIS
by Ben Gutshall, ATG Law Clerk

EDITOR'S NOTE: Although not intended to be an exhaustive explanation, this article provides a thorough overview and serves as a useful starting point for determining tax liability for the sale of a residential property. This article cites information found in the IRS Publication 523: Selling Your Home (2003) available at www.irs.gov/publications/p523.

Introduction


The sale of a residential property is often a complicated procedure. It requires all parties, especially the seller and the closing agent, to pay attention to all details of the transaction in order to complete the process. When selling residential property, one must carefully consider the tax implications. In Illinois, the sale of residential property can result in federal income tax liability, as well as real estate transfer taxes. Buyers also need to be aware of the implications of buying property from foreign sellers because of special federal requirements that apply to the sale of property by foreign citizens. This article provides an introduction to the various tax implications of selling residential property in Illinois and also provides citations to the various applicable tax statutes for further review.

Federal Income Tax: Gain on the Sale of Real Estate


Under federal tax law codified in the Internal Revenue Code, the sale of a residential property may be subject to an income tax if a gain is realized on the sale (26 USC, § 1, et seq. (I.R.C.)). Therefore, the first step in determining potential federal income tax liability on the sale of a residential property is to determine if the seller realized a "gain."

Determining the Amount of Gain (I.R.C. § 1001)

Generally, the amount of gain from the sale of a home is determined by subtracting the selling expenses from the selling price to compute the amount realized on the sale. This amount is then reduced by the adjusted basis of the home to find the gain or loss from the sale of the home.

Amount Realized on the Sale: The amount realized on the sale is calculated by subtracting the selling expenses from the selling price. The selling price is the gross amount the seller received for the home. Selling expenses include commissions, advertising fees, legal fees, and loan charges paid by the seller, such as loan placement fees.

Adjusted Basis of the Home (I.R.C. § 1011): The seller must know the basis of the home before determining the adjusted basis. Typically, the basis is the home's cost when the seller bought or built it. If acquired in some other manner (inheritance or gift, for example), the basis is either the home's fair market value when the seller acquired it or the adjusted basis of the property at the time the seller acquired it from the prior owner. To calculate the adjusted basis of the home, the seller must identify any increases or decreases in the home's basis since the seller acquired it.

Increases to Basis (I.R.C. § 1016). Typical increases to the basis of a home include the following: (1) additions or other improvements that have a useful life of more than one year; (2) special assessments for local improvements; and (3) amounts the seller spent after a casualty to restore damaged property.

Decreases to Basis (I.R.C. § 1016). Typical decreases to the basis of a home include the following: (1) gain the seller postponed from the sale prior to May 7, 1997, of a previous home; (2) deductible casualty losses; (3) insurance payments the seller received or expected to receive for casualty losses; (4) payments the seller received for granting an easement or right-of way; (5) depreciation allowed or allowable if the seller used the home for business or rental purposes; (6) residential energy credit (allowed from 1977 through 1987) claimed for the cost of energy improvements that the seller added to the basis of the home; (7) adoption credit the seller claimed for improvements added to the basis of the home; (8) nontaxable payments from an adoption assistance program of the seller's employer that the seller used for improvements that were added to the basis of the home; and (9) energy conservation subsidy excluded from the seller's gross income because the seller received it - directly or indirectly - from a public utility after 1992 to buy or install any energy conservation measure.

Computing the Gain: Once the amount realized on the sale and the adjusted basis of the residential property have been calculated, the seller subtracts the adjusted basis of the residential property from the amount realized on the sale. A positive number is the gain on the sale of the residential property.

Exclusion of Gain from the Sale of the Seller's "Primary Residence" (I.R.C. § 121). Typically, the gain realized from the sale of an individual's "main home" qualifies for a complete or partial exclusion from federal income tax that releases the seller from liability for federal income tax on that gain. Ordinarily, to exclude the gain from the sale of a primary residence, the seller must have owned and lived in the property as the seller's "main home" for at least two years during the prior five-year period. The seller's primary residence, or "main home," can be a house, houseboat, mobile home, cooperative apartment, or condominium. Sales of non-residence land and/or land adjacent to the seller's home are treated differently than sales of a primary residence, and the resulting gains are not likely to be eligible for exclusion. However, the sale of vacant land adjacent to land on which the seller's home rests may be excluded if, among other requirements, this land was owned and used as part of the seller's main home and the qualifying sale of the home occurred within two years before or two years after the date of the sale of the vacant land.


Only one house can qualify as the seller's main home and this is the only home for which the seller is allowed to exclude gain under the current system. The determination of which of multiple houses is the main home will be based on a variety of factors, including the time spent by the owners in that home, where the owners are employed, the mailing address used by the owners for bills and correspondence, the location of banks used by the owners, the location of recreational clubs and religious organizations of which the owners are members, the location of the owner's family members' main homes, and the address given on the owner's federal and state tax returns, driver's license, car registration, or voter registration card. If the main home is also used for business purposes, then this fact will affect the excludability of gain from its sale as discussed later in this article.

The Maximum Exclusion (I.R.C. § 121(b)). The seller can exclude up to $250,000 of the gain of the sale of the seller's main home under the following conditions: (1) the seller meets the ownership test; (2) the seller meets the use test; and (3) during the prior two-year period ending on the date of the sale, the seller did not exclude gain from the sale of another home.


The seller can exclude up to $500,000 of the gain of the sale of the seller's main home under the following conditions: (1) the seller is married and files a joint return for the year; (2) either the seller or the seller's spouse meets the ownership test; (3) both the seller and the seller's spouse meet the use test; and (4) during the prior two-year period ending on the date of the sale, neither the seller nor the seller's spouse excluded gain from the sale of another home.

The Ownership and Use Tests (I.R.C. § 121(a)). To claim the exclusion, the seller must meet the ownership and use tests. Ultimately, this means that during the five-year period ending on the date of the sale, the seller must have met two requirements: (1) the seller owned the home for at least two years; and (2) the seller lived in the home as the seller's main home for at least two years. It is important to note that the required two years of ownership and use during the five-year period ending on the date of the sale do not have to be continuous. The seller meets the tests if the seller can show that the seller owned and lived in the property as the seller's main home for either 24 full months or 730 days (365 times two) during the five-year period ending on the date of sale. Further, the seller can meet the ownership and use tests during different two-year periods. However, the seller must meet both tests during the five-year period ending on the date of the sale.

Reduced Maximum Exclusion (I.R.C. § 121(c)). If the seller owned and lived in the property as the seller's main home for less than two years, the seller might still be able to claim an exclusion. The amount varies depending on the circumstances, but the seller might qualify for a reduced exclusion if either of these conditions apply: (1) the seller did not meet the ownership and use tests; or (2) the seller sold more than one home during the two-year period, and the primary reason that either (1) or (2) is true is because of a change in the seller's place of employment or health, or is due to unforeseen circumstances as defined in the Internal Revenue Code.

More than One Home Sold during Two-Year Period (I.R.C. § 121(b)). Generally, the seller cannot exclude gain on the sale of the seller's home if, during the two-year period ending on the date of the sale, the seller sold another home at a gain and excluded all or part of that gain. If the seller cannot exclude the gain, the seller must include it in the seller's income. As described above, the seller might still be able to claim a reduced exclusion if the primary reason the seller sold more than one home during the two-year period was because of a change in place of employment or health, or due to unforeseen circumstances.

Reporting the Sale: The seller has to report the sale of a main home on his or her tax return only if there is a gain and the seller either does not qualify to exclude all of it or chooses not to exclude it.

Forms. If the seller has any taxable gain on the sale of the seller's main home that cannot be excluded or the seller does not want to exclude the gain, the seller must report the entire gain realized on Schedule D (Form 1040). If the seller used the home for business or to produce rental income, the seller may have to use Form 4797 to report the sale of the business or rental part or the sale of the entire property if used entirely for business or rental.

Deducting Taxes in the Year of Sale and the 1099-S Form:
Real Estate Taxes. The seller and the buyer must deduct the real estate taxes on the home for the year of sale according to the number of days in the real property tax year that each owned the home. I.R.C. Section 164(d) specifically refers to allocating property taxes between buyer and seller. The seller is treated as paying the taxes up to, but not including, the date of sale. The seller can deduct these taxes as an itemized deduction on Schedule A (Form 1040) in the year of sale. It does not matter what part of the taxes the seller actually paid. The buyer is treated as paying the taxes beginning with the date of sale. If the buyer paid the seller's share of the taxes, or any delinquent taxes owed, the payment increases the selling price of the home.

1099-S Form. The 1099-S form reports the sale or exchange of real estate and generally is required to report any transaction that involves the sale or exchange of land, permanent structures (including any residential, commercial, or industrial building), condominium unit, or stock in a cooperative housing corporation. Typically, the person responsible for closing the sale (generally the settlement agent) must file Form 1099-S. I.R.C. § 6045; 26 CFR § 1.6045-4. The information on the 1099-S must include in Box 5 the part of any real estate tax that the buyer can deduct. If the seller actually paid the taxes for the year of sale, the seller must subtract the amount shown in Box 5 of Form 1099-S from the amount the seller paid. The result is the amount of tax the seller can deduct.


The following do not require reporting and/or filing of a 1099-S form:

  1. Sale or exchange of a principal residence, including stock in a cooperative housing corporation, for $250,000 or less ($500,000 or less for married individuals filing a joint return). Note, however, that the reporting requirement looks to the sales price, not the amount of gain.



  2. Any transaction in which the transferor is a corporation, a governmental unit (including a foreign government or an international organization), or an exempt volume transferor. An exempt volume transferor is someone who sold or exchanged during the year, or who sold or exchanged in either of the two previous years, at least 25 separate items of reportable real estate to at least 25 separate transferees. Additionally, each item of reportable real estate must have been held, at the date of closing, or will be held, primarily for sale or resale to customers in the ordinary course of a trade or business.



  3. Any transaction that is not a sale or exchange, including a bequest, a gift (including a transaction treated as a gift under Section 1041), and a financing or refinancing that is not related to the acquisition of real estate.



  4. A transfer in full or partial satisfaction of a debt secured by the property. This includes a foreclosure, a transfer in lieu of a foreclosure, or an abandonment.



  5. A de minimus transfer for less than $600.



  6. If a transaction is not related to the sale or exchange of reportable real estate, the following are not reportable:
    1. an interest in crops or surface or subsurface resources, including timber, water, ores, and other natural deposits;



    2. a burial plot or vault; and



    3. a manufactured structure used as a dwelling that is manufactured and assembled at a location different from that where it is used, but only if such structure is not affixed, on the closing date, to a foundation. This exception applies to an unaffixed mobile home.

Incorrect Information on the 1099-S Form.If a seller believes that the closing agent misreported his or her gain to the IRS, using the 1099-S form, the seller's only remedy is to correctly report the gain on the seller's individual tax return. If the closing agent incorrectly reported the gain on the 1099-S form, the closing agent can be penalized for the incorrect reporting under code Section 6721.

Transfer Taxes.The seller cannot deduct transfer taxes, stamp taxes, and other incidental taxes and charges on the sale of a home as itemized deductions. However, if the seller pays these amounts as the seller of the property, they are expenses of the sale and reduce the amount the seller realizes on the sale.

Related Issues:
Foreclosure or Repossession (I.R.C. § 1038; § 121(d)).If the seller's home was foreclosed or repossessed, then the transaction is viewed as a sale. Generally, the seller will receive from the lender Form 1099-A: Acquisition or Abandonment of Secured Property. This form will have the information the seller needs to determine the amount of gain. If the seller's debt is canceled, the seller may receive Form 1099-C: Cancellation of Debt.

Business Use of the Seller's Home (I.R.C. § 121).The seller who meets the ownership and use tests can usually exclude the gain from the sale of a home that the seller has used for business or to produce rental income.

Qualified Personal Residence Trusts (QPRT) (I.R.C. § 2702).A QPRT is specifically permitted under the Internal Revenue Code. The owner transfers title to the home to a QPRT, retaining the right to continue to use the home for a specified term. The seller or the seller and the seller's spouse can be the trustees of the trust. The QPRT allows an owner to take the tax advantages of the mortgage interest deduction and the ability to avoid up to $500,000 of gain on sale (assuming that the owner and the spouse qualify for the maximum exclusion). Additionally, if the owner survives the term of the QPRT, the owner's right to use the home terminates when the QPRT term terminates and the residence will not be included in the owner's estate for estate tax purposes.

Federal Income Tax: Foreign Sellers


The Foreign Investment in Real Property Transfer Act (FIRPTA), 26 USC § 1445(a), makes buyers liable for the seller's federal income tax on a sale of real property by certain foreign persons. Under the Act, any transferee (buyer) of a United States real property interest must withhold an amount equal to ten percent of the amount realized in the transaction by the transferor (seller). The buyer must record the seller's taxpayer identification number (TIN) on applications for withholding certificates and other notices or elections under Sections 897 and 1445. The requirement to withhold applies to every real estate transaction except transactions wherein one or more of the following apply:

  1. The seller furnishes an affidavit to the buyer that states that the seller is not a foreign person and discloses the United States TIN of the seller; or



  2. The interest transferred is an interest in a domestic corporation (e.g., common stock) and the corporation furnishes an affidavit to the buyer that states that the corporation is not and has not been a United States real property corporation during the applicable period set forth in 26 USC § 897(c)(1)(ii); or



  3. The Treasury Department furnishes a "qualifying statement" exempting the buyer from the obligation to withhold; or



  4. The property is acquired by the buyer for use by him as a personal residence and the amount realized by the seller does not exceed $300,000; or



  5. The interest transferred is a share of a class of stock in a corporation regularly traded in an established securities market.

In practice, many real estate transactions will not require the actual withholding of proceeds because they will qualify for exemption (d) above, since they involve the purchase of a home for the buyer with a sale price of $300,000 or less.

Illinois Real Estate Transfer Tax Law


In Illinois, "a tax is imposed on the privilege of transferring title to real estate, as represented by the deed that is filed for recordation, and on the privilege of transferring a beneficial interest in real property that is the subject of a land trust as represented by the trust document that is filed for recordation." 35 ILCS 200/31-10. The tax applies to "any natural individual, firm, partnership, association, joint stock company, joint adventure, public or private corporation, limited liability company, or a receiver, executor, trustee, guardian or other representative appointed by order of any court" that transfers an ownership interest in real estate. 35 ILCS 200/31-5. An outline of the pertinent provisions of the Illinois Real Estate Transfer Tax Law is found below. Also, county boards and home rule counties can impose additional real estate transfer taxes (see the end of this article).

Requirements for a Transfer Declaration and What It Must ContainUnder Section 31-25, "at the time a deed or trust document is presented for recordation, there shall also be presented to the recorder or registrar of titles a declaration, signed by at least one of the sellers and also signed by at least one of the buyers in the transaction or by the attorneys or agents for the sellers or buyers." This transfer declaration must include the following, among other things: (1) the full consideration for the transferred property; and (2) the value of personal property sold with the real estate. 35 ILCS 200/31-25 (a); (j).

Tax Rate under the Illinois Real Estate Transfer Tax Law

The tax rate under the Illinois Real Estate Transfer Tax Law is $0.50 for each $500 of value or fraction of $500 stated in the declaration required by the transfer declaration under section 31-25. 35 ILCS 200/31-10. If, however, the deed or trust document states that the real estate is transferred subject to a mortgage the amount of the mortgage remaining outstanding at the time of transfer is excluded from the basis of computing the tax. 35 ILCS 200/31-10.

Exemptions from the Illinois Real Estate Transfer Tax Law

The following transfers of real estate are exempt from the Illinois Real Estate Transfer Tax Law:

  1. Deeds representing real estate transfers made before January 1, 1968, but recorded after that date. 35 ILCS 200/31-45(a).



  2. Trust documents executed before January 1, 1986, but recorded after that date. 35 ILCS 200/31-45(a).



  3. Deeds to or trust documents relating to:
    1. Property acquired by any governmental body or from any governmental bodies 35 ILCS 200/31-45(b);



    2. Property or interests transferred between governmental bodies 35 ILCS 200/31-45(b);



    3. Property acquired by or from any corporation, society, association, foundation or institution organized and operated exclusively for charitable, religious, or educational purposes 35 ILCS 200/31-45(b).



    4. NOTE: Deeds or trust documents falling within exemptions 3a, b, or c, above (other than those in which the Administrator of Veterans' Affairs of the United States is the grantee pursuant to a foreclosure proceeding) shall not be exempt from filing the declaration. 35 ILCS 200/31-45(b).

  4. Deeds or trust documents that secure debt or other obligation. 35 ILCS 200/31-45(c).



  5. Deeds or trust documents that, without additional consideration, confirm, correct, modify, or supplement a deed or trust document previously recorded. 35 ILCS 200/31-45 (d).



  6. Deeds or trust documents in which the actual consideration is less than $100. 35 ILCS 200/31-45 (e).



  7. Tax deeds. 35 ILCS 200/31-45 (f).



  8. Deeds or trust documents that release property that is security for a debt or other obligation. 35 ILCS 200/31-45 (g).



  9. Deeds of partition. 35 ILCS 200/31-45 (h).



  10. Deeds or trust documents made pursuant to mergers, consolidations or transfers or sales of substantially all of the assets of corporations under plans of reorganization under the Federal Internal Revenue Code or Title 11 of the Federal Bankruptcy Act. 35 ILCS 200/31-45 (i).



  11. Deeds or trust documents made by a subsidiary corporation to its parent corporation for no consideration other than the cancellation or surrender of the subsidiary's stock. 35 ILCS 200/31-45 (j).



  12. Deeds in which there is an actual exchange of real estate and trust documents in which there is an actual exchange of beneficial interests, except that the money difference or money's worth paid from one to the other is not exempt from the tax. These deeds or trust documents, however, shall not be exempt from filing the declaration. 35 ILCS 200/31-45 (k).



  13. Deeds issued to a holder of a mortgage, as defined in Section 15-103 of the Code of Civil Procedure, pursuant to a mortgage foreclosure proceeding or pursuant to a transfer in lieu of foreclosure. 35 ILCS 200/31-45 (l).



  14. A deed or trust document related to the purchase of a principal residence by a participant in the program authorized by the Home Ownership Made Easy Act, except that those deeds and trust documents shall not be exempt from filing the declaration. 35 ILCS 200/31-45 (m).

County Real Estate Transfer Tax

The county board may impose a tax upon the privilege of transferring title to real estate. 55 ILCS 5/5-1031. The tax rate is "25 cents for each $500 of value or fraction thereof stated in the declaration required by Section 31-25 of the Property Tax Code." 55 ILCS 5/5-1031. The exemptions found in Section 31-45 above also apply to this section. 55 ILCS 5/5-1031.

Home Rule Real Estate Transfer Tax

After giving public notice and submitting the proposed tax to a referendum vote, a home rule county can impose or increase a tax or other fee on the privilege of transferring title to real estate. 55 ILCS 5/5-1031.1.

Conclusion


To summarize, the two major tax implications for sellers of Illinois residential real estate are the Federal income tax on "gain" from the sale of the property and the Illinois Real Estate Transfer Tax (including any additional taxes that counties or municipalities have imposed). In addition, when buying from a foreign seller, a buyer must be aware of the additional requirements described in this article.

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